Why don’t banks and traditional lenders provide funds to startups?

I'm with Michael on this one. This can be a very loaded question, Trevor, but at face value, there won't often be a good fit. Lenders and investors are different species and rarely have the same objectives. Startups have good reason to approach both, but it really only makes sense to call on lenders when they need operating capital to manage cashflow. This presumes there are customers and revenues in place, against which a lender can secure their capital and set the terms of doing business . Lenders can help startups by providing revolving credit, and aside from security on their capital, they're happy earning interest. Investors, on the other hand, are in it for the home run, not a few points for interest. Very different objectives, and their money is used for different purposes.

It is pretty much a matter of banking regulation and economics; the majority of start-ups don't have sufficient collateral to pass muster at a bank and regulations may require sufficient collateral.

In my Silicon Valley consulting practice, I work with many start up companies that are starved for cash, the answer to this question affects many of the firms I know. If they could qualify for debt financing, they would certainly approach lenders.

From the lenders point of view, which is critical to the credit decision, there must be cash flow from which to repay the loan. Many startups do not yet have revenues or predictable cash flow. Banks are not keen to finance operating losses. They view this as the job of the venture or angel investor who will earn a large return if the company is successful. The goal of the bank is to finance timing differences in cash flow, for example the time needed to collect accounts receivable or for inventory to turn. For a business that has cash flow, a bank may provide a longer term loan for equipment financing.

Here in Silicon Valley, there are some specialized forms of lending that are based primarily on bridging from a current funding round to an upcoming round, which is presumed to be quite likely based on the prospects of the company. This kind of financing will only be available to those firms that have existing large VC firms behind them who are unlikely to allow the firm to fail with the loan unpaid. Very few firms will qualify for this kind of financing.

For those entrepreneurs that have the resources, providing a personal guarantee may be worth the risk and with collateral the bank may provide required funding. In a retail business run by my wife a number of years ago, we obtained bank funding in this way for a number of years, which we paid off over time. For those unwilling to obtain funding this way and tempted to use credit cards or other unsecured debt, I urge them to avoid this due to the very high interest rate, problems this will cause with their personal credit rating and ease of taking on new debt without thinking much about it. It is better to take the time to locate Angel investors who may provide enough money to avoid this kind of risk.

Trevor,

The reality is that the majority of all startups will fail within two years and even fewer will see their 5th anniversary. Larry is right, unless a borrower has the resources and collateral to support the loan bank auditors will rate this loan as more risky loan which may cause additional problems for the bank. Are there still new businesses securing bank financing? Yes, but in today's market you may see more banks trying to have this backed by the SBA to reduce their overall risk. To secure a bank loan you will need to have the following items:

1. Very well thought out business plan that documents the product/service, target market, competitors, monthly cash flow projections and more.
2. Personal financial statement that offers some level of security for the bank to say "yes". You WILL sign a personal guaranty and you will very likely need to put up your home or other assets as collateral.
3. Personal credit - know your personal credit score and what it means.
4. Think about your contingency plans if the business doesn't take off as fast as you plan. What options do you have to pay your personal and business loans/debts.

If you are looking for a bank loan to start your business you should be able to provide a strong reason for the bank to say "yes" and back it up with your signature.

There is also the problem that good bankers, who pride themselves on reduced risk and safety, do not have experience or the mindset to match entrepreneurs with a "damn the torpedoes" mentality necessary to hit a home run. So, even if they did lend, you probably wouldn't want them to, since they would be the first to bail at the news of any negative event.